Dan Seif is vice president for market development at 7X Energy, a Texas-based solar developer.

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Let’s stop pretending that we’re paying for “energy” via our home power bills and understand that we’re mainly paying for infrastructure.

Home electric bills have long been priced volumetrically (per kilowatt-hour, or unit of electric energy consumed), with only some small additional fixed charges like a meter charge and/or local fixed surcharges. Yet this legacy charge structure does not reflect the paydown on our grid’s sunk capital costs, nor does it do much to encourage customer load changes that reduce the need for more grid infrastructure.

It also fails to allow homeowners and renters to fully capture the value of new residential technologies such as smart-home control systems, batteries and electric water heaters. 

Instead, we should allow all consumer classes — but most impactfully, the residential class — to opt into billing based on a three-part structure that relates to how their energy use actually impacts the system. Here are those three parts:

1. Energy use (per kWh): This is the amount of electricity you use each month measured in kilowatt-hours (kWh). Customers are paying for the ongoing cost of generating the power that reaches their residence. In electric industry-speak, this rate structure is “volumetric.”  
2. Distribution (per kWNCP): This is the customer’s kilowatt overall peak power use in any given billing month. You are paying for your burden on the local distribution wires system. Paying down the capital costs of the distribution line on your street is much more closely associated with the maximum amount of power it must handle in a given month or year than the amount of energy it’s carrying at any given moment. In electric industry-speak, this rate structure is based on non-coincident peak (NCP). Your residential load performance on an NCP basis also affects the need for future upgrades of your local distribution system.
3. Transmission (per kWCP): This is the residential customer’s annual or semi-annual energy use when the regional transmission grid is at its coincident peak (CP). Here you are paying for your burden on the regional transmission system. The cost of paying down the sunk cost of your region’s high-voltage transmission system is much more closely associated with the moment, or top few moments, of maximum power provision in a given year than with the amount of energy it’s carrying at any given moment. Your residential load performance on a CP basis also affects the need for future upgrades of your regional grid. Similar considerations apply to generation capacity system costs, whereby certain generators and sometimes demand response are paid for being available at grid load peak moments; those should be combined into this CP-based cost.

Three-part rates: There’s nothing new here

A billing system based on volumetric consumption alone mainly incentivizes one energy action by the end user: efficiency measures with year-round impact, like procuring a more efficient refrigerator or lightbulb.

But more substantial efficiency actions that are seasonally effective could save the homeowner more on a three-part bill. For most of the U.S., electric heating and, in particular, cooling, dwarf other categories of power consumption in the home, even on a year-round basis. 

Heating or cooling efficiency actions that reduce a residence’s peak load, such as a more efficient air conditioner, can pay out handsomely against both NCP- and CP-based rates. Furthermore, predictive-intelligence driven smart thermostats and home energy storage systems should pay out much better against CP-based rates than current volumetric-only ones.

The three-part rate structure described above is already common for large commercial buildings in several states, so it’s hard to argue that providing this structure to another class of customers (residential) would be a wild idea.

It’s also effectively what many distribution-level utilities already face: They are exposed to both volumetric wholesale energy costs and CP-based transmission charges.

Where NCP- and CP-based rates are in effect, they are the result of long-standing political compromises between different consumer groups, utilities and their regulators. Any one of these groups can point out the very real techno-economic and fairness imperfections in these rate structures. But these NCP- and CP-based rates structures have been the prevailing structures for decades, and they create price signals generally agreed to be more indicative of both sunk and future infrastructure costs than volumetric rates.

The rise (and rise) of wire costs

Some large build-outs of transmission and distribution equipment more than pay for themselves, such as very high-voltage lines from strong renewable resource areas to high load areas. Universal resistance to T&D infrastructure build-out is foolish. 

But the overall level of increase in T&D spending and annual rate-base payback versus flat U.S. load is suspect and unsustainable — and would still be high even without these prominent high-voltage build-outs. For instance, in ERCOT territory in Texas, the transmission cost recovery tariff increased by about 5 percent per year (~3x inflation) over 10 of the past 13 years, with the three years excluded being those in which ERCOT’s prominent high-voltage build-out project were added to the ERCOT rate base.

For more than 100 years, the majority of residential power bills were linked to wholesale energy costs. This made volumetric-only residential bills a fairly reasonable approach. Now, however, three-quarters of residential power bills are composed of “other costs” (see Figure 1 below). These costs are primarily tied to payback on transmission and distribution sunk costs, such as wires, towers, poles and substations.

Figure 1: Cost and cost share of average U.S. residential power bill

In fact, on a national basis, these other costs have risen on average by nearly five times the U.S. inflationary rate (~8 percent per year) since 2007 with no increase in national load to dilute down the cost increases in power bill rates. Only a few states (most notably California and New York) have taken material action to manage these escalating costs with new regulatory structures to better allow for demand response, storage and other new technology solutions.

And even where action is being taken, wires cost escalation is a train running downhill. When the emergency brake is pulled, it still takes a long time to stop the momentum, not to mention reverse it.

Having NCP- and CP-responsive technologies will be critical to lowering costs to the consumer as the vast majority of value in the system going forward will be dominated by NCP- and CP-associated T&D infrastructure costs.

The takeaway

The reality is that smart home control systems, batteries and electric water heaters will never reach their sales potential under the current approach to calculating residential power bills.

It’s time for those companies, particularly large-balance-sheet entrants (e.g., Amazon Echo, Google Home) to start thinking about their relationship with state public utility commissions and their billions of dollars of unrealized revenue stemming from the lack of three-part rates. CP-based rates, in particular, can pay out extremely well, with the opportunity to push a homeowner’s $/kWCP cost nearly to zero.

Instead of advocating for CP-based rates for none (such as removing these rates from large commercial and industrial accounts), consumer advocacy groups should be pushing for CP-based rates for all. 

Many citizens will prefer the simplicity of volumetric rates and may not be ready to adopt some technologies that lower bills based on three-part rates. That’s fine, and it’s why any new billing options should be just that — optional. Consumers should be able to choose between options for how their power bill is structured and not be forever committed to one or the other.

Allowing price signals to more clearly reflect the costs of the power grid will help to lower residential energy bills for those who procure the right in-home technologies. It will also reduce the need for future grid upgrades, thus providing the double benefit of also reducing the cost of future residential energy bills for all.

The need to offer opt-in three-part rates to electricity consumers has never been more pressing. Transmission and distribution costs now dramatically outweigh wholesale energy costs, at nearly three to one, and they are relentlessly increasing. Meanwhile, the technological solutions now available to us to manage and respond to these costs with three-part rates are smarter, cheaper and more readily implementable than ever before.